Flexible spending becomes a little less flexible

Maryalene LaPonsie |
December 7, 2010

Flexible spending accounts offer what might be the most marvelous little tax break available to American families for medical expenses. It is almost a crime that so few people know about them and even fewer use them in conjunction with their health insurance plan. Unfortunately, all good things must come to an end, and it appears that the IRS is beginning to put the nails into the account's coffin.

Why don't you have a flexible spending account?

If you're not familiar with flexible spending accounts, it's time to learn more about the tax savings you've been missing out on all these years.

Unlike many IRS creations, flexible spending accounts can be surprisingly user friendly. First, you sign up for an account through your employer during the open enrollment period. When you enroll, you need to estimate your annual out-of-pocket medical expenses. Then, your employer deposits pre-tax money from your paycheck into the account each pay period.

When you have a medical expense, you can either pay for it out-of-pocket and ask for reimbursement or use a handy debit card issued by some plans to pay expenses directly.

The beauty of flexible spending accounts is that not only are your medical expenses tax-free, your account will also advance you the money if needed. For example, let's say on January 15th, you go into the hospital and have to pay a $500 health insurance plan deductible. Assuming your annual election for the flexible spending account is more than $500, your account will pay the entire deductible immediately, even if your account only has an actual balance of $20.

All good things must come to an end

To be clear, there has been no announcement that flexible spending accounts are being eliminated. However, in 2011, there will be changes to the accounts that will make them a little less appealing.

For starters, access to over-the-counter medications is being severely limited. In the past, if you had extra money left in your account (you must use all your money each year or lose it), you could sashay through the pharmacy section and stock up on cold medicines, Tylenol and other over-the-counter remedies. Now, the IRS says you need a prescription to use your flexible spending account to pay for those purchases.

A prescription for Tylenol? What will they demand next?

While the IRS is allowing some over-the-counter purchases, such as band-aids and crutches, to be reimbursed by flexible spending accounts, it angered a legion of mothers by declining to include breastfeeding pumps and supplies as approved expenses. This is despite a request from the American Academy of Pediatrics and a research study that concluded that 900 preemie baby deaths could have been averted if they had been breastfed.

Finally, the IRS is limiting how much you can spend tax-free each year on your health care. Starting in 2013, you will only be able to deposit $2,500 in your account each year. Hope you don't have two kids who need braces then. Your group health insurance probably won't pay for it, and now you won't be able to put it on the flexible spending account either.

Interestingly, the Patient Protection and Affordable Care Act is to thank for these changes. If you are confused about how these changes fit in with patient protection or affordable care, join the club. It's a mystery to us.